Real Economic Shocks and Sovereign Credit Risk

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We provide new empirical evidence that U.S. expected growth and consumption volatility are closely related to the strong co-movement in sovereign spreads. We rationalize these findings in an equilibrium model with recursive utility for CDS spreads. The framework nests a reduced-form default process with country-specific sensitivity to expected growth and macroeconomic uncertainty. Exploiting the high-frequency information in the CDS term structure across 38 countries, we estimate the model and find parameters consistent with preference for early resolution of uncertainty. Our results confirm the existence of time-varying risk premia in sovereign spreads as compensation for exposure to common U.S. macroeconomic risk.